Birla Technology of Science and Technology Pilani, Hyderabad Campus

ISSUES IN ECONOMIC
DEVELOPMENT
Presentation: Paper Summary

“Do Institutions Cause Growth”

Edward L. Glaeser, Rafael La Porta, Florencio Lopez De-Silanes and Andrei Shleifer

Group No: 4

Siddarth Baldwa 2018B3A70914H

Nimish Prabhune 2018B3AA0940H

Kedar Charkha 2018B3A70912H

Ayushman Upreti 2018B3A30196H

Aman Mahajan 2018B3A70880H

Submitted to: Dr. Durgesh C Pathak (Dated: 9th Sept, 2020)

 Do Institutions Cause Growth?

Since the study and research of economics has established and diversified, each country is in

the quest to achieve broadly two targets - economic growth and development. Here, it is worth

mentioning that a well-established and properly regulated institutional body (like a democracy)

is a pre-cursor for development, as only such an institution can guide the leaders to work for

the welfare of the people.

Thus, for decades we have had public policy researchers, growth and developmental

economists, and institutional economists, who have tried to determine the path for developing

nations to achieve economic growth. The research paper by Glaeser et al. (2004) analyses two

such paths which have been proposed by previous research.

The first proposed path is the Institutional View. It is believed that a constrained

institution is a pre-cursor for a developing country to achieve economic growth. A developing

country must start its quest by pushing for an institutional change to a constrained institution.

Only when such constraints are put in place, can the leaders work on securing property rights

and accumulating physical and human capital. This will then lead to the Economic Growth of

the Country.

The second path, the Development View, differs. It believes that even dictators can

work on pro-market initiatives (securing property rights and accumulating capital) - as a

political choice, rather than a constraint. This is followed by Economic Growth and widespread

education. Once the citizens are educated, they can question the shortcomings of the existing

institutions, and push for a more democratic form of government.

Thus, further discussion ensues in the paper, on whether the claim made by the institutional

view – that institutions cause growth – is valid or not.

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The study goes on to show that the Institutional Measurement techniques, which are currently

used, are conceptually inaccurate and hence unreliable. Here, the definition of Institution has

been complemented to reflect the idea of 'permanent' or durable constraints.

The definition of Institution has been complemented with the idea of 'permanent' or

durable constraints. Unlike Democracy, where the constitution and electoral rules put

constraints on the executive powers, good policy chosen by dictators with a free hand cannot

be considered as an institution. The major challenges are that these subjective assessments are

outcome measures and do not consider either limitations on the government or

permanent/durable highlights of the political scenario. Instead, they are exceptionally unstable

and keep fluctuating. Furthermore, they are so constructed that they do not distinguish between

constrained governments and pro-market dictatorship respecting property rights. After

regressing political and human capital variables, it is concluded that the persistence of human

capital is not only more than measures of constraint on government, but they are less volatile

than the other polity variables. We observe that firstly, the conventional measures of

institutional quality are strongly correlated with per capita income. This result is expected as

institutions have a positive effect on growth, but it also reflects reverse causal effects.

Secondly, proportional representation and plurality are correlated with per capita income,

weaker than those of the conventional indices. Finally, the measures of judicial checks and

balances are uncorrelated with per capita income of the country, and only judicial independence

very weakly correlates with the outcome. We can infer that either these constitutional measures

are too noisy, or that the correlation between development and "institutions" results from

institutional outcomes just being better in richer countries, rather than institutions causing

growth. Nevertheless, these are the variables for measuring institution quality.

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In section 3 of this paper, the authors try to find if there is a statistical relationship between

political institutions, human capital, and economic growth. The statistical tool used to find the

relationship is the Ordinary Least Square (OLS) method. In total, 3 OLS regressions are carried

out to analyse the relationships. All the OLS regressions give similar results.

The first OLS regression is carried out by keeping the growth of per capita as the

dependent variable whereas initial education, share of countries' population in the temperate

zones, and additional eight institutional variables are taken as independent variables. The

period considered is between 1960 and 2000. The regression results strongly indicate that initial

education can strongly predict subsequent economic growth.

The second OLS regression is carried out by dividing the period of 1960 to 2000 decade

wise. The dependent variable is the growth rate of GDP per capita, and the independent

variables are initial GDP per capita, initial years of schooling, initial executive constraints.

Even in this model, there is no statistical evidence that initial executive constraints can predict

growth - however, human capital is a strong predictor.

The third OLS regression is carried out only for those countries for which data for initial

executive constraints, initial years of schooling is available for the period between 1870 to

1950. This model primarily tries to predict if there is long term growth for the countries

considered. Again, there is no evidence that executive constraints can predict economic growth.

However, there is some evidence that human capital can predict growth.

In conclusion, there was no statistical evidence found in any of the OLS models that

could support the idea of institutions causing economic growth.

Next, the Authors consider human capital and political institutions in the sample of poor

countries of the 1960s. Samples are divided based on the schooling years per capita. Further,

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each sample is independently divided (using 1960-2000 Polity IV democracy score) into four

categories, namely democracies, imperfect democracies, imperfect autocracies, autocracies.

From the data, it is understood that all stable democracies are highly educated countries.

It is seen that countries with high human capital in 1960 have grown twice as fast, as compared

to low human capital countries. It is also deduced that the stable democracies have grown much

quicker than the autocracies—higher distribution in growth rates across dictatorships than

democracies.

The high dispersion rates of poor countries lead to another reason for doubt about the

precedence of political constraints for economic development, as nearly all poor countries in

1960 were dictatorships. The evidence is at least suggestive these are the choices made by

dictators than the constraints on them that helped some poor countries come out of poverty.

Further analysis suggested that considering constraints on government as a starting reform for

the emergence of countries from poverty may have been incorrectly positioned, and the growth

of human capital might have been more productive.

In Section Five, the authors analyze how various researchers tried to solve the problem of

growth, leading to better institutions. The authors specifically focus on settler mortality and

1500 population density as instrument variables for modern-day political institutions

constraining the executive.

Findings show that even though these instruments are highly correlated with

institutional measures like average expropriation risk and average executive constraints, they

have several drawbacks. Firstly, these instruments show insignificant to no correlation with

other constitutional and judicial measures. Secondly, a surprisingly high correlation is seen

between the proposed instruments and modern-day disease environment (using malaria risk

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and malaria ecology as variables), thus concluding that these instruments have an undesirable

independent effect on human capital, development and institutions.

Next, with the help of concrete evidence, the authors state that the instruments used by AJR

impact the per capita growth of the region using channels other than political institutions. They

prove this by showing that average years of schooling and number of primary school

enrolments (which significantly influence growth) are highly correlated with the proposed

instrument variables. They also present the results of an IV estimation framework suggesting

human capital to be more significant in predicting development than political institutions.

Finally, the authors discard the instrumental variables approach to explain the causes of growth

by stating the ambiguity of colonial settlement's impact on growth.

The authors make one final attempt to establish the primacy of schooling over

institutions using lagged regressions. It is seen that lagged values of schooling (at time t)

significantly predicted the future institutional changes after a span of 5 years (t+5) – while the

reverse was not true. This reinstated the fact that education could lead to institutional changes,

as proposed in the Development Model.

In conclusion, most of the evidence furnished in the paper has pointed to the primacy

of capital over growth and democratization. However, this cannot be declared as definitive due

to inaccurate institutional measurements and constraints on econometric techniques available.

That being said, there is enough evidence to signal that the claim that institutions cause growth

can be definitely challenged.

Here, another point to note is that the paper does not undermine the merits of

Democracy. It merely states it is not a pre-cursor to economic growth. That being said, as

mentioned in the introduction, a well-suited institution is required for inclusive development

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of the people; and a democracy is arguably one of the most people-friendly institutional

frameworks prevalent in the world!

Reference:

Glaeser, E. L., La Porta, R., Lopez-de-Silanes, F., & Shleifer, A. (2004). Do institutions

cause growth?. Journal of economic Growth, 9(3), 271-303.